Panicked Investors Flee Putin’s Russia in Droves

For Russia’s leadership, it seemed everything had gone right. In three weeks, the country had invaded Georgia, crushed its military and defied international opinion by recognising the breakaway republics of South Ossetia and Abkhazia. Western threats came to nothing. Russia’s attack on Georgia went unpunished.

But victory has been undermined by an alarming flight of capital. Analysts estimate that, since the war began on August 8, $19bn (£10.7bn) has been withdrawn from the country. The Kremlin is also facing other economic problems. They include a rapid drop in the oil price, which has fallen almost 30% from peaks close to $150 a barrel, and a 9.7% increase in inflation since the start of the year.

Analysts believe the war could become a catalyst for a more profound slowdown following at least seven years of unprecedented economic growth. So far the Kremlin has managed to unite Russians in support for the invasion of Georgia. But as the economy cools, the euphoria is wearing off.

“The war in Georgia has been the major driver of the whole thing. Officially capital flight has been $19bn. We estimate it could be $20bn-$25bn,” said Vladimir Osakovsky, a Moscow-based analyst at UniCredit.

“For most of this year we were viewed as a safe haven. Capital was flowing into Russian markets and into Russian funds. We have lost this safe-haven sense.”

According to Osakovsky, the decline began not with the war in Georgia but in late July, when the prime minister, Vladimir Putin, launched an extraordinary attack on the mining and metals company Mechel. Mechel’s share value plunged 38% on the New York stock exchange after Putin threatened to “send doctors” to examine its owner. Mechel shares lost $6bn in one day. Meanwhile, there is lively debate behind closed doors in the Kremlin. According to Andrei Piontkovsky, a researcher at the Russian Academy of Sciences, writing in the Moscow Times, Russia’s political elite is split between the national and global kleptocrats.

The global kleptocrats have invested most of their assets in the west, and are fearful that Russia’s confrontation with Nato could escalate into a full-blown conflict. The national kleptocrats, by contrast, have stashed their billions inside Russia. They have less to lose should Russia try to repeat its military success in Georgia in other post-soviet states such as Estonia or Ukraine.

It is no secret that Russia’s elite send their children to English private schools, have houses in London’s Mayfair and South Kensington, and enjoy skiing holidays in the French Alps. The EU has failed to find effective ways to persuade Russia to end its occupation of Georgia, but few doubt that the most devastating tactic would be to refuse Kremlin officials Schengen visas.

“It is becomingly increasingly difficult for them [the global kleptocrats] to explain why their wives and children are buying palaces in the capitals of countries that are supposedly Russia’s sworn enemies,” Piontkovsky wrote in the Moscow Times.

Russian firms, meanwhile, are finding it harder to raise credit on international money markets. The Russian stock exchange has slumped to its lowest level for two years. And yesterday another 7.5% was wiped off shares as a result of the political crisis in neighbouring Ukraine, whose pro-western government has just collapsed. But as Neil Cooper of the Russo-British Chamber of Commerce points out, growth is still much higher than in Britain. “If you compare it with what’s going on at home, it doesn’t look too bad,” said Cooper. “There is a slight slowdown [in Russia]. But nobody is immune to these reverberations around the world.” He said growth rates in Russia were buoyant. “The consensus is that Russia is still a place to be and a place to invest in. This is a land of opportunity,” he said.

Certainly Russia is well placed to ride out a financial crisis. Its oil-driven international reserves yesterday stood at $582.5bn, up a billion over the last week. President Dmitry Medvedev has shrugged off talk of capital flight and, in an interview on Tuesday, blamed recent problems on the US. “It’s 80% due to negative events in the US and 20% due to Georgia,” he said. The US had to sort out its mortgage system and add liquidity to its financial markets, he added. When he became president in May, Medvedev was hailed as a new kind of leader – a reformist, a long-time fan of the British rock band Deep Purple, possibly even a liberal. After less than three months in the job, however, he has invaded Georgia, fallen out with the west and seemingly given up on early promises to end corruption.

Although Russia’s economy is expected to bounce back, it will take a long time for the country to recover its reputation as a risk-free investment destination.

Asked to sum up the consequences of the war in Georgia for Russia’s relations with the west, Grigorii Golosov, politics professor at the European University of St Petersburg, said: “Pure deterioration.”

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